View of part of the Fujairah Corniche and the Hajar Mountains in the Background

Saturday, June 9, 2007

The Black Swan Syndrome: How Cyclone Gonu is Raising Oil Prices

Oil prices began to climb higher on Wednesday as eyes were focused on the pathway of Cyclone Gonu from Oman, brushing the coast of the UAE and proceeding towards the Persian Gulf.

On the New York Mercantile Exchange, the price of light, sweet crude for July delivery was up 15 cents US at $65.76 US a barrel.

Why did Gonu lift the oil prices?

The storm caused little damage to Oman's small oilfields and no damage to UAE fields. It was some concern that the cyclone would reach the Iranian coast on Thursday but it was weakening and its centre was far from Iran's offshore oil installations.

The high seas prevented tankers from sailing from Omani ports and the large bunkering port at Fujairah. There were fears that the storm could disrupt oil shipments through the Strait of Hormuz where one-fifth of the world's oil passes at the south-eastern entrance to the Persian Gulf. With 17-21 million barrels a day of oil coming out of the Persian Gulf some tanker delays, could reduce the supply of oil and increase prices.

Is this a case of putting up the prices simply to cover the bases and insure against the possibility of damage to oil plants and the disruption of oil exports? How much skulduggery is involved in bumping up the price when a disaster is on the cards?

Dan Denning of the Australian web site The Daily Reckoning had another explanation for the oil price increase—the Black Swan syndrome. On 6 June 2007 he writes:

“Boy do we love a good Black Swan. And this could be a good one. Global oil prices are up on the chance that the cyclone could hit the southern coast of Iran and disrupt shipping and production of oil in the Gulf.”

“A Black Swan, by the way, is the term philosopher Nassim Taleb uses for a low probability, high impact event; they are so named because until Europeans found Black Swans everywhere in Australia, they were considered so rare as to be statistically insignificant. A cyclone impairing or destroying production capacity in the world’s most important oil region certainly qualifies as a Black Swan.”

“But here’s the thing. As Taleb points out, Black Swans are not as rare in financial markets as today’s modern financial models would suggest. They are more common than you’d expect. And the funny thing is, as the world’s financial markets become more complex and more integrated, Black Swans seem to be taking flight with increasing frequency. Hmm.”